A certificate of deposit is a savings account where you agree to leave your money untouched for a set period in exchange for a higher interest rate
A certificate of deposit, or CD, is a straightforward agreement between you and a bank. You give the bank a sum of money — anywhere from $500 to $100,000 or more, depending on the bank — and promise not to touch it for a fixed time period. In return, the bank pays you a higher interest rate than you would earn in a regular savings account. The bank knows exactly when you will withdraw the money, so it can lend that money out with confidence, and it rewards you for that certainty.
The money you put in is called the principal. The interest the bank pays you is added to that principal. When the CD reaches its maturity date — the end of the agreed time period — you get back your principal plus all the interest earned. You can then withdraw the money, renew the CD for another term, or move the money elsewhere.
Key Takeaways
- A CD locks your money away for a set period (typically three months to five years) in exchange for a may provide interest rate higher than a savings account offers.
- You know exactly how much interest you will earn before you open the CD, because the rate is fixed for the entire term.
- Withdrawing money before the maturity date usually costs you a penalty, often equal to several months of interest.
- CDs are insured by the FDIC up to $250,000 per account, so your money is protected even if the bank fails.
- Different banks offer different rates and terms, so comparing options before you open a CD can mean earning significantly more interest.
How the interest rate and term length work together
When you open a CD, the bank tells you two things: the annual percentage yield (APY) and the term. The APY is the interest rate you will earn, stated as a percentage per year. The term is how long your money stays locked in — common terms are three months, six months, one year, two years, three years, and five years.
Longer terms usually come with higher APY rates. A one-year CD might pay 4.5 percent APY, while a five-year CD at the same bank might pay 5.2 percent. The bank is willing to pay more because it gets to hold your money for longer. The trade-off is that you give up access to that money for a longer time.
The interest is calculated and added to your account automatically. Some banks add it monthly, some quarterly, some at maturity. The exact schedule is in the CD agreement. What matters is that once interest is added, it earns interest too — this is called compounding. A $10,000 CD earning 5 percent APY for one year will grow to $10,500, and that extra $500 is yours to keep.
What happens when your CD reaches maturity
On the maturity date, the bank sends you a notice — usually 10 to 30 days before the date arrives. At that point, you have choices. You can withdraw all the money (principal plus interest) with no penalty. You can open a new CD with the same bank, either for the same term or a different one. Or you can move the money to a different bank or account type.
If you do nothing, many banks will automatically renew your CD for another term at whatever the current rate is. This can work in your favor if rates have risen, but it can work against you if rates have fallen. Read the maturity notice carefully so you know what will happen if you do not act. Some banks give you a grace period — usually 7 to 10 days after maturity — during which you can withdraw without penalty even though the new term has technically started.
The early withdrawal penalty and when it applies
The main catch with a CD is the early withdrawal penalty. If you need the money before the maturity date, you can take it out, but the bank will charge you a fee. That fee is usually equal to a few months of interest — sometimes three months, sometimes six, sometimes a full year depending on the bank and the term length.
Here is a real example: you open a two-year CD with $10,000 at 4.5 percent APY. After eight months, you need the money for an emergency. You can withdraw it, but the bank deducts a penalty — say, six months of interest, which is about $225. You walk away with $9,775 instead of the $10,300 you would have had at maturity. The penalty comes out of your interest first, then out of your principal if the interest is not enough to cover it.
Some banks offer no-penalty CDs, which let you withdraw early without a fee. The trade-off is that these CDs pay a lower interest rate than traditional CDs. Whether a no-penalty CD makes sense depends on how confident you are that you will not need the money.
FDIC insurance protects your money
When you open a CD at a bank, your money is protected by FDIC insurance — the Federal Deposit Insurance Corporation. This means that if the bank fails, the government guarantees you will get your money back, up to $250,000 per account. This protection applies to the principal you deposited plus all the interest earned, as long as the total does not exceed $250,000.
If you have more than $250,000 to put into CDs, you can open accounts at different banks to stay within the insurance limit at each one. You can also open CDs in different ownership categories — for example, one in your name alone and one in a joint account with your spouse — and each category is insured separately.
Comparing CD rates across banks
CD rates vary widely between banks. On the same day, one bank might offer 4.2 percent APY on a one-year CD while another offers 5.1 percent. Over a year, that difference adds up: on a $10,000 CD, the higher rate earns you $90 more in interest. Online banks and credit unions often offer higher rates than large brick-and-mortar banks because their costs are lower.
Before you open a CD, spend 10 minutes checking rates at a few different banks. You can compare rates on websites that list them, or you can visit bank websites directly. Pay attention to the term length — a rate that looks great for a five-year CD might be ordinary for a one-year CD. Also check whether the bank has any minimum deposit requirement or monthly fees that would eat into your earnings.
CDs versus savings accounts and money market accounts
A CD is different from a regular savings account in one key way: you lock your money away and get a higher interest rate in return. A savings account lets you withdraw money anytime without penalty, but the interest rate is usually much lower — often less than 1 percent APY. If you know you will not need the money for at least a few months, a CD almost always pays more.
A money market account sits in the middle. It pays more interest than a savings account but usually less than a CD. It also lets you write checks or make withdrawals, though often with a limit on how many per month. If you want some flexibility but also want to earn more than a savings account pays, a money market account might fit better than a CD.
Frequently Asked Questions
Can I withdraw money from a CD before it matures?
Yes, you can withdraw anytime, but you will pay an early withdrawal penalty. The penalty is usually several months of interest. Some banks offer no-penalty CDs that let you withdraw without a fee, but these pay lower interest rates than traditional CDs.
What is the difference between a CD and a savings account?
A CD locks your money for a set time and pays higher interest in return. A savings account lets you withdraw anytime but pays much lower interest. If you will not need the money for several months or longer, a CD usually earns significantly more.
Is my money safe in a CD?
Yes. CDs at banks are insured by the FDIC up to $250,000 per account. If the bank fails, the government guarantees you will get your principal and interest back. You can open CDs at multiple banks to protect more than $250,000.
What happens to my CD when it reaches maturity?
The bank sends you a notice before the maturity date. You can withdraw the money with no penalty, open a new CD, or move the money elsewhere. If you do nothing, many banks automatically renew the CD at the current rate, so read the notice carefully.
Do I have to pay taxes on CD interest?
Yes. The interest you earn on a CD is taxable income. The bank will send you a 1099-INT form at tax time showing how much interest you earned. You report this on your tax return just like any other interest income.